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Will The Post-Election Rally In Stocks Continue?

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
November 9, 2004

IN THIS ISSUE:

1.  Stocks Surge Higher Following The Election

2.  Will The Rally Continue Or Fizzle Out?

3.  The Mountain Of Cash In Money Market Funds

4.  What Happens If Stocks Turn Lower Again?

5.  What My Favorite Equity Managers Are Doing Now

6.  Stratfor.com’s Analysis Of Bush’s Second Term

7.  The Best Quote Of The Week From Andy Rooney

Introduction

The stock markets rallied strongly last week after the election, not only here in the US but in much of the rest of the world as well, as I predicted in my October 19 E-Letter.  In that issue, I suggested that stocks would rally regardless of who won the election, and I recommended that investors increase their equity holdings ahead of the election.

Those who took that advice have enjoyed the latest bounce in the stock markets.  Yet the major market indices still have not broken out of the year-long trading range.  I continue to believe that equities have a “window of opportunity” to rise over the next six months or longer.   But as always, I could be wrong.

I believe that one of the major factors in the direction of the stock markets is whether or not millions of investors decide to get off the sidelines and get back into stocks and mutual funds.  There is still a mountain of cash sitting in money market funds earning next to nothing.  These frustrated investors could drive stock prices significantly higher – if they decide finally to get back in the market.

After we ponder the prospects for the stock markets, I bring you the latest thinking from our old friend, Dr. George Friedman, founder of the widely followed Stratfor.com.  George gives us his insights on President Bush’s second term. 

Stocks Surge Following Election Results

The stock markets soared on the upside following the news that President Bush won the election.  The Dow Jones and the S&P 500 rallied almost 4% last week following the election results.  The Dow climbed to 10,400 for the first time since early July.  Stock market exuberance was not limited to the US Markets.  The French stock market, surprisingly, rose 2.8% last week, while the German market rose 2.5%.  I thought the French and the Germans loathed George W. Bush.

But is the stock market surging ahead because Bush won?  Or is it simply because all the uncertainty is finally over?  Or is it because oil prices have cooled a little?  The answer is: all the above.  Now it remains to be seen if the stock market can break out of the year-long trading range which has seen the Dow Jones meander back and forth between 9,800 and 10,600. 

My feeling is that the stock markets will break out to the upside, but I could certainly be wrong.  I continue to believe that there is a window of opportunity for stocks to rise over the next six months and possibly longer.  The question is how much, and the answer is anybody’s guess.

Will The Mountain Of Cash Finally Jump In?

Market analysts on both sides of the fence (bulls and bears) make eloquent cases for why the equity markets should move higher or lower.  As I discussed last week, the economy remains on a solid growth path, but with GDP growing at a sub-4% pace, it is not as if the next few years will be smooth sailing for the Bush administration or the Fed.

At this point, neither the bullish case nor the bearish case for equities is overwhelmingly compelling.  Both arguments have their points.  Sometimes that’s just the way it is.  But there is one point on which most bulls and bears generally agree on.

One of the biggest factors that will determine whether equity prices trend meaningfully higher just ahead is whether or not the owners of the mountain of cash parked in money market funds decide to get back in the market.

Assets in money market funds exploded in late 2001 and early 2002 as the bear market in stocks unfolded.  As losses mounted, investors bailed from stocks and mutual funds and moved what was left of their money to the safety of money market funds.  According to the Investment Company Institute (ICI), which tracks money flows into and out of mutual funds, cash held in money market funds peaked in February 2002 at $2.3 trillion (that’s trillion with a T). 

Based on ICI money flow reports, many investors missed the strong rally in stocks that occurred from March of 2003 to March of this year.  Assets in money market funds declined only slightly from $2.2 trillion in March 2003 to $2.0 trillion in March of this year.

Apparently, not many investors agreed with my advice in March of last year when I recommended that they move back to a fully invested position in stocks and mutual funds just before the war in Iraq began.  Too bad – the S&P 500 Index gained almost 33% in the 12 months ended in March of this year.

In its latest report, ICI says there is still $1.92 trillion parked in money market funds.  And this brings us back to the question: what will it take to bring a big chunk of this mountain of cash back into the markets and drive prices above the recent trading range? 

A clear victory by President Bush?  Maybe.  The market moved up almost 4% last week, but still did not break out of the trading range.  Better than expected economic news?  Maybe.  The unemployment report last Friday showed 337,000 new jobs in October.  That’s a good start.  Oil prices down to the $40 area?  That would definitely excite the equity markets.  But as this is written, oil is still above $48.

And If We Don’t Breakout To The Upside?

In the October 19 issue of this E-Letter, I again recommended that investors increase their exposure to equities, and I made the case that stocks could rally regardless of who won the election.  I wrote:

“Given this outlook, and the fact that interest rates are still very low, I continue to believe that stocks have a window of opportunity over the next year or so to move higher.  I believe that if President Bush is re-elected, we could see stocks begin to trend higher again.
For the record, I do not expect a multi-year bull market to unfold anytime soon.  In fact, I don’t expect the markets will make it to their all-time highs seen in late 1999 or 2000 again anytime soon.  But if the S&P 500 were to move up to 1,400 from 1,100 presently, that’s definitely a move worth participating in.”

As this is written, I stand by that recommendation.  The Dow has risen from below 9,900 on October 20 to near 10,400 as of today.  It remains to be seen if the post-election rally will continue, or if we stay in this frustrating trading range. As noted above, I expect the equity markets to break out to the upside, but we should also talk about what happens if they don’t.

Frankly, it will be very disappointing if the equity markets don’t break out of the year-long trading range in the next couple of weeks.  If the stock markets fail to break out decisively above the trading range highs of 10,600 in the Dow and 1165-1170 in the S&P 500, then we will likely see renewed selling.  And if that is the case, it will not surprise me to see the markets break out on the downside.  Should that happen, I would recommend reducing exposure to equities.

I Leave Those Decisions To The Professionals

I read dozens of publications that analyze and forecast the economy, interest rates and the investment markets.  I use all of these resources when making periodic predictions on the trends in the economy and the markets.  I have been making such predictions in my monthly newsletter, which you can read free of charge at my website, for over 20 years.

Yet it is important for you to know that all of the money I have in the markets is managed by professionals that make all the decisions to buy or sell.  These professional money managers use time-tested systems which tell them whether to be fully invested, partially invested or on the sidelines.  My forecasts are not a part of the equation.

At the moment, the professional Advisors I recommend are - by the nature of their positions - in general agreement with my stock market outlook noted above.  As this is written, these Advisors are “long” in the stock market, but are not fully invested.  My two favorite equity managers are apprx. 80% invested in mutual funds as this is written, with apprx. 20% in cash.

The point is, while I will continue to offer forecasts on the economy, interest rates and the markets, you should know that my investment portfolio is 100% managed by professional Advisors that make the decisions for me (save for a few real estate holdings I own). 

This E-Letter is sent to 1½-2 million people each week.  In such a broad audience, there are no doubt some among you who are extremely sophisticated when it comes to analyzing the economy and investing in stocks, bonds and other markets.  But most of you, I’m sure, either are not so experienced in managing money and/or you don’t have time to watch the markets all day. 

For those of you in the latter category, I continue to suggest that you could benefit from having professional money managers on your team.  I invite you to check out some of the money managers I recommend by clicking here.  Or you can call us at 800-348-3601 for a free consultation.

Bush’s Second Term – Stratfor.com’s Analysis

If you have read this E-Letter for long, you know that we are big fans of Stratfor.com.  Stratfor is one of the most respected sources for geopolitical analysis and global intelligence in the world.  In the pages which follow, I have reprinted Dr. George Friedman’s latest analysis of President Bush’s second term.  George talks about the election, what Bush is likely to do in his second term, about the war in Iraq, and about what could go wrong for the president.  I trust you will find it interesting and insightful as usual.

QUOTE:
The Second Term
November 05, 2004 

By George Friedman

The election is over and the worst did not happen. The United States is not locked in endless litigation, with the legitimacy of the new government challenged. George W. Bush has been re-elected in a clear victory. Depending on your point of view, this might have been the best imaginable outcome or the second-worst possible outcome. Possibly, for some, it is the worst outcome, with complete governmental meltdown being preferable to four more years of Bush. However, these arguments are now moot. Bush has been re-elected, and that is all there is to that.

This means that for slightly more than four years the United States will be governed by a president who will never run for political office again. In general, two-term presidents tend to be less interested in political process than in their place in history. They tend to become more aggressive in trying to complete their perceived missions, and less cautious in the chances they take. Richard Nixon, Ronald Reagan and Bill Clinton all encountered serious problems in their second terms, most due to their handling of problems they experienced in their first terms. Nixon had Watergate, while Reagan was handling Central American issues and hostages. Clinton wound up impeached for his handling of matters in his second term.

Going further back in the century, Woodrow Wilson had the League of Nations fiasco in his second term, and Franklin D. Roosevelt tried to pack the Supreme Court. Dwight Eisenhower alone, his place in history assured, did not suffer serious setbacks from misjudgments, unless you want to view Sputnik, Yuri Gagarin and the shooting down of the U-2 over Soviet air space as personal failures.

Second-term presidents tend to look at re-election as vindication of their first-term policies and as a repudiation of their critics. They see themselves as having fewer constraints placed on them, and they become less sensitive to political nuances. Bush is an interesting case because he was not particularly sensitive to political nuance in his first term. It is difficult to remember a president in his first term who was less constrained by political considerations or political consequences. For better or worse, Bush did not govern with one eye on public opinion polls. As we learned in the course of his term, he was not particularly flexible, even when he was running for re-election. We therefore need to imagine a George W. Bush who is not relatively, but completely, indifferent to political nuance.

Add to this that his legacy is far from assured. Bush's presidency will be measured by one thing: Sept. 11 and his response to it. It is far from clear how history will judge him. There are many parts to the puzzle -- from Iraq, to homeland defense to Pakistan and so on. They are moving parts. For Bush to assure his legacy, he must bring the conflict to a successful conclusion -- not easy for a conflict in which success remains unclear.

We therefore have two forces at work. First, second-term presidents tend to feel much greater freedom of action than first-term presidents -- and tend to take greater risks. Second, Bush enters his second term with greater pressure on his legacy than most presidents have. Bush needs to make something happen, he needs to get the war under control, and he does not have all that much time to do it. If he is to complete his task before the end of his second term, he needs to start acting right now. It is our expectation that he will.

His re-election represents the first step. Globally, there was a perception that Bush had blundered massively. There has also been a long-standing myth that the United States cannot stand its ground because casualties generate decisive antiwar movements. In spite of the fact that Nixon buried George McGovern in 1972, and followed with the Christmas bombing of Hanoi, global expectations have always been that events in Iraq would generate a massive antiwar movement that would force Bush from office.

This expectation was first shaken by Sen. John Kerry's campaign. For all his criticism, Kerry did not campaign against the war. He campaigned against Bush. This was explained in many circles as merely what Kerry had to say to get elected, and that after election his true colors would emerge. However, to more sensitive ears, the fact that Kerry had to campaign as he did in order to have a hope of election was jarring. The antiwar vote was too small for the theory. With Bush's victory, one of the fundamental assumptions about the United States went out the window. In spite of casualties and grievous errors, not only was there no antiwar candidate (save Ralph Nader), but Bush actually won the election.

This puts in motion two processes in the world. First, there is a major rethinking of American staying power in the war going on. The assumption of a rapid conclusion of the Iraq campaign due to U.S. withdrawal is gone – and it is surprising just how many non-Americans believed this to be a likely scenario. The reassessment of the United States is accompanied by the realization that the United States will not only maintain its pressure in Iraq, but on the region and the globe itself.

American pressure is not insubstantial. Virtually every country in the world wants something from the United States, from a trade agreement to support on a local conflict. They can do without an accommodation with the United States for months, but there is frequently serious pain associated with being at odds with the United States for years. Throughout the world, nations that have resisted U.S. actions in the war -- both within and outside of the region -- must now consider whether they can resist for years.

We can expect two things from Bush in general: relentlessness and linkage. Having won the election, Bush is not going to abandon his goal of crushing al Qaeda and pacifying Iraq and, indeed, the region. That is understood. Equally understood is that Bush will reward friends. Bush's test of friendship is simple: support for the United States and, in particular, support for the policies being pursued by his administration in the war. For Bush, active support for the war was a litmus test for good relations with the United States during the first term. The second term will make the first term look gentle.

Countries that made the decision not to support Bush did so with the assumption that they could absorb the cost for a while. They must now recalculate to see if they can absorb the cost for four more years – and even beyond, if Bush's successor pursues his policies. For many countries, what was a temporary disagreement is about to turn into a strategic misalignment with the United States. Some countries will continue on their path, others will reconsider. There will be a reshuffling of the global deck in the coming months.

The same analysis being made in the world is also being made in Iraq. There are the guerrillas, most of whom are committed to fighting the United States to the death. But the guerrillas are not a massive force, and they depend for their survival and operational capabilities on a supportive population. In Iraq, support comes from the top down. It is the tribal elders, the senior clergy and the village leaders who make the crucial decisions. They are the ones who decide whether there will be popular support or not.

There has been an assumption in Iraq -- as there has in the world -- that as the pressure builds up in Iraq, the United States will move to abandon the war. Bush's re-election clearly indicates that the United States will not be abandoning the war. They are therefore recalculating their positions in the same way that the rest of the world is. Holding out against the Americans and allowing their populations to aid the guerrillas made a great deal of sense if the United States was about to retreat from Iraq. It is quite another matter if the United States is actually going to be increasing pressure.

It is no accident that as Election Day approached, U.S. forces very publicly -- and very slowly -- massed around Al Fallujah. Al Fallujah was the town in which the United States signed its first accord with the guerrillas. As the election approached, the town went out of control. Now the election is over, the town is surrounded and Bush is president. It is a time for recalculation in Al Fallujah as well, as there can be no doubt but that Bush is free to attack and might well do it.

Throughout the Sunni areas of Iraq -- as well as Shiite regions -- elders are considering their positions, caught between the United States and the guerrillas, in light of the new permanence of the Americans. The United States will be aggressive, but in an interesting way. It will be using the threat of American power as a lever to force the Sunni leadership into reducing support for the guerrillas. Coupled with the carrot of enormous bribes, the strategy could work. It might not eliminate the guerrilla war, but could reduce it to a nuisance level.

The basic reality thus creates the strategy. The re-election of Bush creates a new reality at all levels in the international system. His intransigence, coupled with American power, forces players to think about whether they can hold their positions for at least four years, or whether they must adjust their positions in some way. As the players -- from sheikhs to prime ministers -- reconsider their positions, U.S. power increases, trying to pry them loose. It opens the possibility of negotiations and settlements in unexpected places.

It also opens the door to potential disaster. The danger is that Bush will simultaneously overestimate his power and feel unbearable pressure to act quickly. This has led some previous presidents into massive errors of judgment. Put differently, the pressures and opportunities of the second term caused them to execute policies that appeared to be solutions but that blew up in their faces. None of them knew they would blow up, but in their circumstances, no one was sufficiently cautious.

It is precisely Bush's lack of caution that now becomes his greatest bargaining chip. But his greatest strength can also become his greatest weakness. The struggle between these two poles will mark the first part of his presidency. We will find out whether the second part will be the success of this strategy or his downfall. The book on George W. Bush will now be written.  END QUOTE.

Best Quote Of The Week

The ever-colorful (and very liberal) Andy Rooney on “60 Minutes” on November 7:

“Television did a good job Tuesday night, I thought. I know a lot of you believe that most people in the news business are liberal. Let me tell you I know a lot of them, and they were almost evenly divided this time.  Half of them liked Sen. Kerry; the other half hated President Bush.” 

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Newt on values and the Bush victory.
http://www.signonsandiego.com/uniontrib/20041107/news_mz1e7newt.html

How Michael Moore helped get Bush re-elected.
http://www.theunionleader.com/articles_showa.html?article=46653

Kerry got help from media and others.
http://www.weeklystandard.com/Content/Public/Articles/000/000/004/885haqnt.asp?pg=1

James Carville evaluates the Democratic party after the loss.
http://www.washtimes.com/national/20041109-120712-7714r.htm

The Brits weigh in on the election: “It was the stupidity, stupid.”
http://www.telegraph.co.uk/opinion/main.jhtml;sessionid=QJ0RC1NVXX55FQFIQMFCM54AVCBQYJVC?xml=/opinion/2004/11/09/do0902.xml&sSheet=/opinion/2004/11/09/ixopinion.html


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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